The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
E l i g i b i l i t y f o r D isc o u n t, Not a l l o f the i n f i n i t e v a r i e t y o f p a p e r which c i r c u l a t e s in the f i n a n c i a l v-orld i s e l i g i b l e f o r re d isc o u n t a t c e n t r a l b a n k s. To be e l i g i b l e , th e p ap er must s a t i s f y c e r t a i n c o n d i tio n s. The fu n c tio n s o f e l i g i b i l i t y r u l e s v a r y . One fu n c tio n i s t o p re v e n t th e bank from t a k in g in p a p e r upon which i t n ay in c u r l o s s e s . A nother i s t o r e s t r i c t th e "c o rip ^ tio n " o f c e n t r a l banka w ith o th e r f i n a n c i a l i n s t i t u t i o n s . U n q u e stio n a b ly th e m ost im p o rtan t fu n c tio n i s t h a t which i s b a se d on th e su p p os i t i o n t h a t im p r o p e r ly draw n/ e l i g i b i l i t y r u l e s w il l s o lv e th e i& o lc problem o f c r e d i t c o n t r o l . Shorn o f d e t a i l s th e m ost oonraon th e o r y o f e l i g i b i l i t y i s t h a t i f c e n t r a l ban ks o o n fin e r e d is c o u n tin g t o p a p e r which " r e p r e s e n t s * go o d s a lr e a d y in e x is t e n c e and moving tow ard a m a rk e t, th e y w i l l a u t o m a t ic a l ly 1. exten d p r e c i s e l y t h e p r o p e r amount o f c r e d i t . The a u to m a tic e l a s t i c i t y t h e o r i s t s w rote t h e i r id e a s in t o th e o r i g i n a l F e d e r a l R e se rv e A c t. S e c t io n 13 o f t h a t A ct p r o v id e d p o s i t i v e l y " . . . a n y F e d e r a l r e s e r v e bank may d is c o u n t n o t e s , d r a f t s , and b i l l s o f exch an ge a r i s i n g o u t o f a o t u a l a o m e r e i t l t r a n s a c t i o n s ; t h a t i s , n o t e s , d r a f t s , and b i l l s o f exch an ge I s s u e d o r drawn f o r a g r i c u l t u r a l , i n d u s t r i a l ^ end coram eroial p u r p o s e s , o r th e p ro o e e d s o f which h ave been u s e d , o r a r e to be u se d , f o r such p u r p o s e s , th e ?e d e r% l R e s e r v e B oard t o have th e r i g h t t o d e term in e o r d e f in e th e c h a r a c t e r o f th e p a p e r ttea eligible, w ith in the m eaning o f t h i s Act«* t h e same p a r a graph provided negatively ". . . su ch d e f i n i t i o n s h a l l n o t in c lu d e n o t e s , d r a f t s , or b i l l s c o v e r in g m erely in v e stm e n ts o r is s u e d o r drawn fo r th e p u rp o se o f c a r r y in g o r t r a d in g in s t o c k s , bon ds, or o th e r in v estm en t s e c u r i t i e s . • . " G e n e r a lly s p e a k in g , i t was th o u gh t t h a t th e s e p r o v i s i , n s would make th e r e s e r v e banks l a r g e l y p a s s i v e . Any in c r e a s e in th e volume o f " a c t u a l c c n n e r c ia 1 t r a n s a c t i o n s * would p r e sum ably r e s u l t in a c o r re sp o n d in g in c r e a s e in n o t e s , d r a f t s , and b i l l s o f e x ch an g e , in s h o r t , in e l i g i b l e reaper. The e l i g i b le p ap er presu m ab ly would f in d i t s way to th e r e s e r v e banks v ia th e member b a n k s, S in c e t h i s p a p e r ( t o g e t h e r w ith g o ld ) form ed th e l e g a l b a o k in g f o r n o t e s , th e p r o c e s s o f d is c o u n t in g th e th e r e s e r v e banks would a u t o m a t ic a l ly c r e a t e th e added c u rre n c y and d e p o s i t s which w ere needed to t r a n s a c t t h e in c r e a s e d volume o f " a c t u a l c o n & e r c ia l t r a n s a c t i o n s . " One S i g n i f i c a n t e x c e p tio n was n ade a t th e o u t s e t , nam ely, "b o n d s end n o t e s è f th e Government o f th e U n ite d S t a t e s * were e l i g i b l e ; b u t t h i s was c l e a r l y view ed a s an e x c e p t io n . The a u t o m a t ic it y o f th e sy ste m was c l e a r l y c o n d itio n e d by th e d e f i n i t i o n o f e l i g i b l e p a p e r . In g r a n t i n g th e r i g h t o f d e f i n i t i o n t o th e B o a rd , th e H ouse Com m ittee on B an kin g and O urrency s t a t e d : " I n view o f th e g r e a t d i f f i c u l t y o f d e f in in g C o m m e rc ia l p a p e r * th e a c t u a l d e f i n i t i o n o f th e same h a s been l e f t t o th e F e d e r a l r e s e r v e b oard in o r d e r t h a t i t may a d j u s t th e d e f i n i t i o n t o th e p r a c t i c e s p r e v a i l i n g in d i f f é r a i t p a r t s o f th e c o u n try in r e g a r d t o th e t r a n s a c t i o n o f b u s i n e s s and t h e m aking o f p ap er»" T a t , a re n t h i s Com m ittee b e lie v e d th e m a tte r o f d e f i n i t i o n t o be t t t f it à ÿ ^ t a s h n lc a l and a g a i n a s s e r t e d : "F o r o b v io u s r e a s p n s i t i s fo r b id d e n t h a t any such p a p e r s h a l l be a d n it t e d t o r e d is c o u n t i f made f o r th e p u rp o se o f c a r r y in g s t o c k s or b o n d s*" 3. In r e a l i t y , t h i s m eant t h a t th e " a u t o m a t ic ” sy stem r e q u ir e d management in th e form o f d e f i n i t i o n o f e l i g i b i l i t y . The B oard soon d is c o v e r e d an e s t a b l i s h e d Am erican i n t e r 4. bank lo a n p r a c t i c e which fa v o r e d th e lo a n o v e r th e d is c o u n t . I t a c c o r d in g ly recoiiiacnded t h a t th e A ct be m o d ifie d " . . . t o en a b le member banks t o o b t a in prom pt and eco n o m ical a co o m ao d atio n s 5. f o r p e r io d s not t o exceed f i f t e e n d a y s . . . " Cn Septem ber 7, 1 9 1 6 # th e A ct was amended t o p r o v id e , among o th e r t h i n g s , t h a t "Any F e d e r a l r e s e r v e bank may make ad v an o es t o i t s nember banks on t h e i r p ro m isso ry n o te s f o r a p e r io d not e x c e e d in g f i f t e e n d a y s ,.p r o v id e d such p ro m isso ry n o t e s a r e se c u r e d by such n o t e s , d r a f t s , b i l l s o f exoh an ge9 o r b a n k e r s ' a c c e p t a n c e s a s a r e e l i g i b l e f o r r e d is c o u n t o r f o r p u rc h a se by F e d e r a l r e s e r v e banks under th e p r o v is io n s o f t h i s A o t, o r bjrthe d e p o s it o r p le d g e o f bonds o r n o te s o f th e U n ited S t a t e s . " Q u a n tita t i v e l y t h i s new av en u e , th e ad v an ce se c u re d by governm ent s e c u r i t i e s , became f c y i a l l odds th e m ost im p o rtan t a c c e s s t o r e s e r v e bank o r e d i t . C o n ttrn in g th e o ld e r d e v ic e , th e d is c o u n t , how ever, th e F e d e r a l R e se rv e B oard p e r s i s t e d in t h e th e o r y o f t h e o r i g i n a l A c t. In Ju n e , 1 9 2 0 , I t r e p o r t e d : "The B o a rd , e v e r s in o e th e e s ta b lish m e n t o f th e F e d e r a l R e se r v e S y stem , h a s c o n s i s t e n t l y ad h ered t o th e p r i n e i p l e t h a t th e q u e s tio n w hether o r n ot th e proceeds of © particular obligation are for u sed defined ii the lav/ must be deternined b£ the use proceeds are put by the Baker of the note. one to of the p u rp o se s which those In accordance with this principle the Board has frequently ruled that the note of a bank, a factor, a credit coxapany, or any fcther such institu tion is not eligible for Sedisoount if the proceeds are used to lend to some third party. The fact that the proceeds may ultimately be used by that third party for a commercial, industrial, or agricultural purpose can not affect the character o f th e o r i g i n a l o b l i g a t i o n so f a r a s th e p r o v is io n s o f th e 6• F e d e r a l R e se rv e A ct a r e c o n c e rn e d ,'' A lthough t h e " p r i n c i p l e " was su p p o se d ly c l e a r , th e Board encoun t e r e d a d m in is t r a t iv e * d i f f i c u l t i e s in a s c e r t a i n i n g e l i g i b l e u s e s o f p r o c e e d s o f d isc o u n te d p a p e r . For ex am p le, in R e g u la t i o n A, I s s u e d on Septem ber 15» 1 9 1 6 , i t was r u le d t h a t "A F e d e r a l R e se rv e Bank m ust be s a t i s f i e d by r e f e r e n c e t o th e n o te o r o th e rw ise t h a t i t i s e l i g i b l e f o r r e d i s c o u n t . C om pliance o f a n o t e . . . may be e v id e n c e d by a sta te m e n t o f th e borrow er showing s r e a s o n a b le e x c e s s o f q u ic k a s s e t s o v e r o u r r e n t l i a b i l 7. it ie s ." O ther f i n a n c i a l r a t i o s o f th e borrow er have a l s o been 8 u se d t o d e te rm in e e l i g i b i l i t y . . E l i g i b l e u s e s o f p r o c e e d s d ig n o t in c lu d e f i x e d o r perman- 9. . 10. e n t o a p i t a l o r w orking c a p i t a l . N e v e r t h e le s s , some h a i r s were 11 s p l i t in fa v o r o f a g r i c u l t u r e . A s i g n i f i c a n t d e p a r tu r e from " t h e p r i n c i p l e c o n s i s t e n t l y ad h ered t o e v e r s in c e t h e e s t a b lis h m e n t o f t h e F e d e r a l R e se rv e S y ste m * w as made in th e r e g u l a t i o n announced by th e B oard on December 1 9 , 1922, G overnor H ardin g w ro te ; "In a c o n v e r s a tio n w ith S e n a to r M cK e lla r, o f T e n n ., whose home i s in Memphis, I su g g e ste d t h a t , In o rd e r t o meet th e w ish e s o f th e Memphis c o tto n f a c t o r s t h a t t h e i r n o te s be d e c la r e d e l i g i b l e f o r r e d i s c o u n t, i t would be n e c e s s a r y t o amend th e law ; and a t h i s r e q u e s t I d r a f t e d f o r him a b i l l which p r o v id e s t h a t 'n o t e s , d r a f t s , and b i l l s o f exch ange o f f a c t o r s is s u e d a s su ch m aking a d v an c e s e x c l u s i v e l y t o p r o d u c e rs o f s t a p l e a g r i c u l t u r a l p r o d u c ts 12 in t h e i r raw s t a t e » h a i l be e l i g i b l e f o r such d i s c o u n t . ' " The , b i l l became law . The r e g u l a t i o n o f December 19» was " i s s u e d f o r th e p u rp o se o f p e r m ittin g F e d e r a l r e s e r v e b an k s t o p u rc h ase in th e open m a r k e t .. .b a n k e r s ' a c c e p t a n c e s , . .draw n by g r o w e rs, o r by c o o p e r a t iv e m a rk e tin g a s s o c i a t i o n s composed e x c l u s i v e l y o f g ro w e rs, o f n o n p e r is h a b le , r e a d i l y m a r k e ta b le , s t a p l e a g r i c u l t u r a l p r o d u c t s , t o f i n a n c e th e o r d e r ly m a rk e tin g a t such p r o d u c ts grown by suc.i g ro w ers and se c u re d a t th e t in e by w areh o u se, t e r m in a l, o r o th e r s i m i l a r r e c e i p t s is s u e d by p a r t i e s In dependent o f th e b o rro w e rs end co n v e y in g s e c u r i t y 13. t i t l e t o such p r o d u c t s ." The A g r i c u l t u r a l C r e d i t s A ct o f Uaroh 1 923, f u r t h e r exten d ed th e p r i n c i p l e o f i n d i r e c t fin a n c in g by g r a n t in g c o o p e r a t iv e a s s o c i a t i o n s th e power t o borrow in o r d e r t o make a d v an o e s t o t h e i r m em bers. T h ese e f f o r t s o f th e B oard a p p a r e n t ly w ere d e sig n e d t o a d a p t th e a u t o a a t i o s e l f - l i q u i d a t i n g e l i g i b i l i t y sy ste m t o A m erican c o n d it io n s , in c lu d in g p o l i t i c a l c o n d i t i o n s . M eanw hile, th e p o s s i b i l i t y o f such an a d a p t a t io n to A m erican Com m erclal p r a e t i o e s r e c e iv e d a body blow in th e e x tre m e ly l a r g e a d v a n c e s o f r e s e r v e bank c r e d i t th rou gh th e in s t r u m e n t a lit y o f governm ent s e c u r i t i e s f l o a t e d to fin a n c e th e w ar. G r a d u a lly th e r e s e r v e o f f i c i a l s began to l o s e f a i t h in th e s e l f - l i q u i d a t i n g th e o ry o f c o n t r o l over th e volume o f c r e d i t even f o r r e g u la r d is c o u n t s . By A u g u st, 1 9 2 1 , r e s e r v e o f f i c i a l s a d m itte d t h a t some r e s e r v e banks r e q u ir e d a d d i t i o n a l c o l l a t e r a l a s a c o n d it io n f o r 14. r e d is c o u n t in g p a p e r . T h is w as a r e c o g n it io n t h a t in p r a c t i c e th e r e s e r v e o f f i c i a l s c o u ld n o t p r e d io t v ;ith c e r t a i n t y w hether " s e l f - l i q u i d a t i n g " p a p e r would in f a c t be l i q u i d a t e d . G overnor S tro n g in d ic a t e d a t th e same t i n e t h a t h is bank d id n o t p ro cee d upon any th e o r y o f a u to m a tic e l i g i b i l i t y r u l e s . He t e s t i f i e d : " . . . . i t would bo a m is ta k e t o a p p ly s e v e r e and te o h n io a l r u l e s in d e te rm in in g what p a p e r was e l i g i b l e upon th e b a s i s o f g o o d n e s s .. .t h e r u l e s which we would a p p ly and th e t e s t s which we would a p p ly in d e te rm in in g th e g o o d n e ss o f com m ercial p a p e r whioh w ere j u s t i f i e d in a p e r io d o f h ig h p r i c e s 15. would no lo n g e r be J u s t i f i e d in a p e r io d o f low p r i c e s . " I n s t e a d o f a m e ch a n ica l a p p l i c a t i o n o f e l i g i b i l i t y r u l e s , th e Hew Y ork bank I n v e s t ig a t e d th e g e n e r a l p o l i c y o f th e a p p l i c a n t member ban k , e s p e c i a l l y r e c e n t c h a n g e s in lo a n s t o th e s t o c k exch an ge and 16. d e a r l a g h ouse b a la n c e s . B a s i c a l l y , in o th e r w o rd s, t e s t s were a p p lie d to th e member bank n o t to th e m aker o f th e n o t e . Tiro s i g n i f i o a h t a d m is s io n s o f in a d e q u a c y o f e l i g i b i l i t y r e q u irm a e n ts b a se d on th e O r ig in o f p a p e r were made by th e B oard in 1 9 2 4 . I t s t a t e d : *1?he B oard i s f u l l y aw are o f th e f a c t t h a t th e problem o f c r e d i t e x te n s io n in v o lv e s th e q u e s tio n o f amount o r volume a s T ,e ll a s th e q u e s tio n o f kind or c h a r a c t e r ; o th e rw ise s t a t e d , in v o lv e s a q u a n t i t a t i v e a s w e ll a s a 17. Q u a li t a t iv e d e t e r m in a t io n ." A t th e same tim e i t a d m itte d : "T h ere a r e no a u to m a tic d e v ic e « o r d e t e c t o r s f o r d e te r m in in g , when c r s d i t i s g r a n te d by a F e d e r a l r e s e r v e bank in r e s p o n s e t o a r e d isc o u n t demand, w hether th e o c c a s io n o f th e r e d is c o u n t . was an e x te n s io n o f c r e d i t by th e member bqnk f o r non16 p r o d u c tiv e u s e . " The argu m en ts o f th e B oard and o f G overnor 19. S tro n g were r e p e a te d on l a t e r o c c a s i o n s . The g i s t o f the p r e c e d in g d i s c u s s i o n i s t h a t th e view p o in t o f th e r e s e r v e o f f i c i a l s changed g r a d u a l l y w ith th e p a s s a g e o f tim e . At th e o u t s e t th e y a tte m p te d t o a d m in is t e r th e A ct in a c c o rd a n c e w ith th e p h ilo so p h y behind i t . O c c a sio n a l l y an a d m in is t r a t iv e r u l i n g was is s u e d w ith p rim ary a t t e n t i o n d lr e o t e d tow ard th e p a r t i c u l a r c irc u m sta n o e s ( in c lu d in g th e p o l i t i c a l f a c t o r ) r a t h e r tfc*n tow ard th e p h ilo so p h y o f th e A c t. G r a d u a lly th e B oard l o s t c o n fid e n c e in th e p h ilo so p h y i t s e l f , sspsot a l l y in v isw o f th e im p o rta n t p o s i t i o n o f governm ent s e c u r itie s. A s o o n f id s n c s w aned, th e e l i g i b i l t y r u l e s w ere » a d s more l e n i e n t . M eanw hile, w r i t e r s d e m o n stra te d th e u n sou n d n ess o f the g e n e r a l th e o r y t h a t p r o p e r e l i g i b i l i t y 20 r u l e s would s o lv e th e p roblem o f c r e d i t c o n t r o l . To be con . s i s t e n t , t h i s th e o r y would assum e t h a t each good would have o u ts ta n d in g and drawn a g a i n s t i t a t e l l t im e s d u r in g i t s l i f e a b i l l ( o r b i l l s ! e q u a l t o th e v a lu e o f th e go o d . T h is a ssu m p tio n was c o n tr a r y t o fact, in t h a t some goods had no bills w hereas o th e r s had s e v e r a l b i l l s a g a i n s t them a t the same t i n e . In o th e r w ords, th e a c t u a l sy ste m o f m a rk e tin g and of fin a n c in g p u r c h a s e s d id not s a t i s f y th e a ssu m p tio n s mkde o f i t by the e lig ib ilit y th e o r ists. Nor w as i t t r u e , a s t h e s e t h e o r i s t s assum ed, t h a t a l l o r e t l e a s t a c o n s ta n t p r o p o r t io n of a l l b i l l s were h eld by th e o e n t r a l b an k . The d e p r e s s io n gave a d ra m a tic coup de g r a c e to e l i g i b i l i t y a s a o o n t r o l d e v ic e . On O ctober 7 , 1 9 3 1 , P r e s id e n t H oover p ro p o se d th e e sta b lis h m e n t o f a n a t io n a l i n s t i t u t i o n " . . . . t h e p u r p o s e ,• . t o be th e r e d is c o u n t o f b an k in g a s s e t s not now e l i g i b l e f o r r e d is c o u n t a t th e F e d e r a l r e s e r v e ban ks in o rd e r t o a s s u r e ou r b a n k s, b e in g so u S d , t h a t th e y may a t t a i n l i q u i d i t y 21 in e s s e o f n e c e s s i t y . " w as: F u rth e rm o re , p o in t 4 o f h i s program " I s h a l l p ro p o se t o th e C o n g re ss t h a t th e e l i g i b i l i t y p r o v is io n s o f th e F e d e r a l r e s e r v e a c t sh o u ld be broaden ed in o r d e r to g iv e g r e a t e r l i q u i d i t y to th e a s s e t s o f t h e b a n k s, and th u s s g r e a t e r a s s u r a n c e t o th e b a n k e rs in th e g r a n t in g o f c r e d i t s by e n a b lin g them t o o b t a in l e g i t i m a t e a c o o m o d a tlo n on sound s e c u r i t y in tim e s o f s t r e s s . " 22. On F e b ru ary 2 7 , 1 9 3 2 , th e O l a a s - S t e a g a l l A ct w as p a s s e d . The f i r s t two s e c t i o n s o f t h i s A ct empowered t h e r e s e r v e ban k s in u n u s u a l, e x i g e n t , o r e x c e p t io n a l o l r ousts t a n c e s t o exten d c r e d i t a c c o m o d a t io n s t o member b an k s which d id n o t h ave a d é q u a t s e l i g i b l e and a c c e p t a b l e p a p e r to s e c u r e accom m odation in th e u s u a l w ay s. S e n a to r G l a s s a tte m p te d t o r e e s t a b l i s h th e o ld p r i n c i p l e s and introduced a bill toontaininf: a section t.> that effect in March. The Board opposed this section of the Glass Bill and inforned Senator Norbeck, "Experience shows that the particular instrument on vrhich Federal Reserve credit is obtained is not an adequate test of the use to be made by t he member bank of 23. th e proceeds of the c r e d i t . . . ." E l i g i b i l i t y o r o v is io n s w ere f u r t h e r r e la x e d by the A c ts o f F eb ru ary 3, Karch 9 , March 24* end I.iay 12, 19 33 The Banking Act of 1933 empowered the reserve banks to refuste to grant credit to a m e m b e r hank oven though it offered good eligible paper by changing the n a n d a t o r y "shall extend" credit t o banks to the permissive "may extend" credit. S q u a lly s i g n i f i c a n t was th e added req u ire m e n t t h a t th e r e s e r v e banks and E o a rd , in e x te n d in g c r e d i t t o member b a n k s, have due r e g a r d t o " t h e m ain ten an ce o f so u jtf c r e d i t c o n d it io n s , . Ad d i t i o n a l amendments f u r t h e r e xten d ed th e l i s t of e l i g i b l e p a p s r and s e c u r i t i e s e s p e c i a l l y in th e d i r e c t i o n s o f e x te n s io n s o f o r e d i t t o i n s t i t u t i o n s and i n d i v i d u a l s which were n ot ineiaber b an k s and i n th e d i r e c t i o n o f in e lu d in g p u b lic and p u b l i o l y g u a r a n te e d s e c u r i t i e s . C o n s tr u e t ic n lo a n s w sre made e l i g i b l e by th e amendment o f JUne 2 7 , 1 9 3 4 . The amendment o f Ju n e 19» 1 9 3 4 , s p e c i f i c a l l y empow ered th e r e s e r v e banks under e x c e p t io n a l c ir c u m s ta n c e s t o make l o a n s to p r o v id e b u s in e s s w ith w orking c a p i t a l . A s i g n i f i c a n t f e a t u r e o f t>^ese amendments i s t h a t th e y were m o d if ic a t io n s o f th e o r i g i n a l th e o r y o f th e A ct ad o p ted in each o s s s t o m est p a r t i c u l a r c o n d i t i o n s . The B an k in g A ct o f 1 9 3 5 , on the other hand, contained a provision whioh abondoned the old theory in prlnolplc. It provided: "Any Federal Reserve bank... may make advanoes to any member bank on its time or demand notes whioh are secured to the satisfaction of suoh Federal Reserve bank." The provision applied only to advanoes yet the ohsnge is fundamental. The Board, in keeping with the ohanges whioh had A bean made in the Aet, issued a nsw Regulation on Discounts for and Advanoes to member banks by Itfderal reserve banks. These rules in effeot made "all sound assets of maaber banks a poten24. tial basis of advanoes by the Federal Reserve banks«" On the other hand, the Board stated that "under the law a bank is not sntitlsd to crsdit fro® a Federal Reserve bank magsly because 25. it has eligible and aoeeptable paper.” The Board said iLtfo new prinsiplss that -they "mark a definite recognition of the fast that the lending funstion of the Federal Reserve banks is not automatic but is an instrumentality of the System's 26 * general credit policy. *
@FedFRASER